War Over Bank Capital Heating Up

The global war over new bank capital requirements for banks is intensifying, with a clash between powerful U.S. regulators drawing widespread international attention.

Bloomberg News

FDIC Chairman Sheila Bair

The latest salvo comes from Federal Deposit Insurance Corp. Chairman Sheila Bair, who penned a sharply worded May 21 letter (Read the letter) in defense of a controversial amendment to the financial overhaul bill that would limit the Federal Reserve’s ability to lower capital requirements.

The Fed and Treasury Department are trying to kill the amendment, written by Sen. Susan Collins (R., Maine). Whether or not it stays in any final bill, it has sparked a bitter feud just as U.S. and global regulators prepare to set new capital rules.

The Collins amendment would essentially force bank holding companies to hold more capital and limit the Fed’s ability to set lower capital requirements. It would also discount certain things that bank holding companies currently consider capital, like trust preferred securities. This could force banks to raise much more capital than they hold now.

The amendment “would constrain the Federal Reserve’s discretion to lower capital requirements below levels that would be implied by the source of strength function expected of holding companies,” Ms. Bair wrote in the May 21 letter to Lawrence Uhlick, chief executive of the Institute of International Bankers.

The FDIC and Fed have often been at odds over how much capital banks should be required to hold, and Ms. Bair successfully pushed for Ms. Collins’s amendment to be accepted unanimously to the bill. To be sure, Treasury and Fed officials have said any new capital standards should force big banks to hold more capital. They just disagree with the manner and the measure that the FDIC is advocating.

Part of the long-running spat between the Fed and the FDIC has to do with the regulators’ different roles: the Fed regulates parent companies with an eye towards the broader financial system.

The FDIC regulates the insured deposit subsidiary bank, which often depends on the parent company as a “source of strength” for capital. If the parent company doesn’t have enough capital to cover losses at the bank subsidiary, the FDIC can lose money. Incidentally, Ms. Bair unsuccessfully pushed for an amendment to the Senate bill that would have allowed the FDIC to serve as “back-up” regulator for parent companies, potentially threatening the Fed’s power.

“Arrangements in which the U.S. holding company structure becomes a vehicle to allow banking organizations to increase their financial leverage beyond what is permissible for insured banks are incompatible with holding companies serving as a source of strength to banks,” she wrote. “As we saw during the crisis, the source of strength doctrine was turned on its head as insured banks often had to come to the aid of their holding companies – holding companies that in too many cases also required substantial federal support.”

Ms. Bair’s letter breaks down the Fed’s approach to capital supervision as she argues why new standards are needed.

“The Federal Reserve does not…expect the parent to satisfy the leverage capital ratios that would be required for a U.S. bank for U.S. Prompt Corrective Action purposes,” she writes. “Indeed, a number of large foreign banking organizations with banking operations in the United States would not currently meet U.S. bank capital standards if they were evaluated on the basis of our leverage requirements.”

Ms. Bair goes on to write that there is a U.S. bank owned by a foreign parent company “with negative tier 1 capital on a consolidated U.S. basis, a consolidation that includes its banking subsidiaries, while its global parent operates with financial leverage well in excess of what is permitted for U.S. banks.”

The Collins amendment caught many off-guard, and now bankers and government officials are scrambling to take it out.

Complicating matters, U.S. officials plan to meet with their global counterparts in July to review data that could direct what new international capital standards might look like. A bitter feud within the U.S. could complicate matters, though it could also force officials to have discussions sooner rather than later about exactly how much capital banks should be forced to hold.

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